Financial analysts have stressed the importance of attaining financial independence at a young age, especially for those youngsters in their 20s who are professionals working in industries. Financial independence is key to early retirement and the concepts are inter-related to each other. If one does not achieve financial independence on time, then it is difficult to retire early. To provide a comprehensive guide on understanding financial independence for early retirement, Chartered Accountant (CA) Rachana Ranade, recently addressed a session in Thrive 2021- an event organised by stocks and mutual funds investments platform Groww.
According to CA Rachana, financial independence means that instead of us working for money, money should work for us. She explained that a movement known as 'FIRE' predominantly started in the US, which comprises of two basic concepts - financial independence and early retirement. FIRE is an abbreviation, in which 'F' stands for financial, 'I' stands for independence, 'R' stands for retire, and 'E' stands for early. (Also Read: Balancing Income And Expenses: How To Create A Monthly Budget And Stick To It )
There are two types of income, explains CA Rachana. One is active income and the other is passive income. Active income is what one earns through a job, by putting in actual efforts in work. Whereas, passive income is what one can earn by not putting in any physical effort. Passive income is mostly earned through investing in equity etc.
Financial independence is achieved when two major conditions are fulfilled. Firstly, if the passive income of an individual exceeds active income, then there is a possibility of achieving financial independence. Secondly, if an individual is not completely dependent on a full-time job, but has other sources of income that can earn revenue, then financial independence can be achieved. The FIRE movement of the US, which zeroes in on early retirement with financial independence, is based upon three major parameters.
- Extreme savings: This means that one needs to save 50 per cent to 70 per cent of income towards savings.
- Concept of frugality: This means that one must think before buying anything. People should purchase things that are needed and money should not be spent on unnecessary items.
- Generating a passive income: The income that one earns through investing and other sources, apart from a job.
How long will it take for you to achieve financial independence?
One can know at what age he/she will retire by following a three-step process, according to the FIRE method:
Step 1: Determine your savings percentage
This means that one must fix a certain amount of percentage of the income for savings. According to FIRE method, it should be around 50 per cent to 70 per cent of total income.
Step 2: Calculate your target retirement amount
For knowing your retirement fund or retirement corpus, multiple your annual expenses with 25. If one needs to know the annual withdrawal amount after retirement, then multiple your retirement corpus amount with four per cent.
Step 3: How long will it take for you to achieve FIRE?
For knowing at what age one will retire, visit http://fireagecalc.com/. Input your data such as the amount of saving, amount of investment etc, and you will be able to find your retirement age.
According to CA Rachana, some of the major points to keep in mind in order to save more and attain financial independence are as follows:
- Redirect your cash gifts or pocket money: Redirect your savings in a bank account which can get you earnings
- Career planning: Plan your career early. If the plans are well executed, one will have high chances of success
- Avoid or minimize debt: Use credit cards wisely and try to avoid debt as much as possible.
- Reduce your spending: The magical formula is Income - Savings = Expenditure. This means that out of your income, you need save first and then make expenses.
- Get yourself insured: Insurance is necessary as one never knows the amount of money required for any unforeseen circumstances
- Build an emergency fund: An emergency fund is crucial for staying financially assured in life.
- Have a back-up plan: No matter how focussed one is to make one plan work, always have a plan 'B', just in case.